Almost exactly 8 years after Greenspan's now infamous "conundrum" comments about the unprecedented persistence of low, long-term interest rates, Bernanke is now "puzzled" at the dramatic rise in interest rates following his recent Taper remarks. Have no fear though, just as Greenspan noted, "I'm reasonably certain we would not automatically assume that it would mean what it meant in the past, " Bernanke said today that the "sharp rise in rates", was not about the Taper but "due to other factors, including optimism about the economy."
Perhaps more importantly, today for the first time someone, not Hilsenrath of course, had the guts to ask Bernanke the hardest question: is the Fed's "Stock not Flow" worldview broken, and was it wrong all along (as we have been alleging all along)? Of course, the implications of the Fed being wrong on this most critical aspect of monetary theory opens up a hornet's next of Pandora's boxes: just what else is the Fed wrong about, and how much will Bernanke be "puzzled" when one by one all of his flawed theories are revealed to be nothing but religious dogma.
And finally what happens to the BOJ when it too has to "taper" and it too realizes that it is all about the flow (in a country where the central bank is monetizing at a relative pace which is more than double the Fed's), and the second sentiment shifts, the entire liquidity bubble comes crashing down, taking not only Japan, but Europe - which is funded courtesy of the Japan carry trade - down with it?
To summarize: bonds collapsing - no worries... it's still the Stock... although not really... and optimism.
From today's press conference:
QUESTION: Mr. Chairman, you've always argued that it's the stock of assets that the Federal Reserve holds which affects long-term interest rates.
How do you reconcile that with the very sharp rise in real interest rates that we've seen in recent weeks? And do you think the market is correctly interpreting what you think is most likely to be the future path of the Federal Reserve's stock of assets? Thank you.
BERNANKE: Well, we -- we were a little puzzled by that. It was -- it was bigger than can be explained, I think, by changes in the ultimate stock of asset purchases within reasonable ranges, so I think we have to conclude that there are other factors at work, as well, including, again, some optimism about the economy, maybe some uncertainty arising. So I'm agreeing with you that -- that it seems larger than can be explained by a changing view of monetary policy.
It's difficult to judge whether the markets are in sync or not. Generally speaking, though, I think that what I've seen from analysts and market participants is -- is not wildly different from what, you know, the committee is thinking and trying -- as I tried today to communicate, I think the most important thing that I just want to convey again is -- is that it's important not to say this date, that date, this time.
It's important to understand that our policies are economic-dependent, and in particular, if financial conditions move in a way that make this economic scenario unlikely, for example, then that would be a reason for us to adjust our policy.
It's really the stock, stupid... (right?)
BERNANKE: And by the same token, as long as we're buying assets, we're adding to our holdings.
We do believe -- although, you know, there's room for debate -- we do believe that the primary effect of our -- of our purchases is through the stock that we hold, because that stock has been withdrawn from markets, and the prices of those assets have to adjust to balance supply and demand, and we've taken out some of the supply, and so the prices go up, the yields go down. So that seems to me consistent with the -- with the idea that we're still adding liquidity, we're still adding accommodation to the system.